Tag Archives: Oil

The Russian central bank opened its first overseas office in Beijing on March 14, marking a step forward in forging a Beijing-Moscow alliance to bypass the US dollar in the global monetary system, and to phase-in a gold-backed standard of trade.

According to theSouth China Morning Postthe new office was part of agreements made between the two neighbours “to seek stronger economic ties” since the West brought in sanctions against Russia over the Ukraine crisis and the oil-price slump hit the Russian economy.

According to Dmitry Skobelkin, the deputy governor of the Central Bank of Russia, the opening of a Beijing representative office by the Central Bank of Russia was a “very timely” move to aid specific cooperation, including bond issuance, anti-money laundering and anti-terrorism measures between China and Russia.

The new central bank office was opened at a time when Russia is preparing to issue its first federal loan bonds denominated in Chinese yuan. Officials from China’s central bank and financial regulatory commissions attended the ceremony at the Russian embassy in Beijing, which was set up in October 1959 in the heyday of Sino-Soviet relations. Financial regulators from the two countries agreed last May to issue home currency-denominated bonds in each other’s markets, a move that was widely viewed as intended to eventually test the global reserve status of the US dollar.

Speaking on future ties with Russia, Chinese Premier Li Keqiang said in mid-March that Sino-Russian trade ties were affected by falling oil prices, but he added that he saw great potential in cooperation. Vladimir Shapovalov, a senior official at the Russian central bank, said the two central banks were drafting a memorandum of understanding to solve technical issues around China’s gold imports from Russia, and that details would be released soon.

If Russia – the world’s fourth largest gold producer after China, Japan and the US – is indeed set to become a major supplier of gold to China, the probability of a scenario hinted by many over the years, namely that Beijing is preparing to eventually unroll a gold-backed currency, increases by orders of magnitude.

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Meanwhile, as the Russian central bank was getting closer to China, China was responding in kind with the establishment of a clearing bank in Moscow for handling transactions in Chinese yuan. The Industrial and Commercial Bank of China (ICBC) officially started operating as a Chinese renminbi clearing bank in Russia on Wednesday this past Wednesday.

“The financial regulatory authorities of China and Russia have signed a series of major agreements, which marks a new level of financial cooperation,” Dmitry Skobelkin, the abovementioned deputy head of the Russian Central Bank, said.

“The launching of renminbi clearing services in Russia will further expand local settlement business and promote financial cooperation between the two countries,” he added according to.

Irina Rogova, a Russian financial analysttold the Russian magazine Expertthat the clearing center could become a large financial hub for countries in the Eurasian Economic Union.

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Bypassing the US dollar appears to be paying off: according to the Chinese State Administration of Taxation, trade turnover between China and Russia increased by 34% in January, in annual terms. Bilateral trade in January 2017 amounted to $6.55 billion. China’s exports to Russia grew 29.5% reaching $3.41 billion, while imports from Russia increased by 39.3%, to $3.14 billion. Just as many suspected, with Russian sanctions forcing Moscow to find other trading partners, chief among which China, this is precisely what has happened.

The creation of the clearing center enables the two countries to further increase bilateral trade and investment while decreasing their dependence on the US dollar. It will create a pool of yuan liquidity in Russia that enables transactions for trade and financial operations to run smoothly.

In expanding the use of national currencies for transactions, it could also potentially reduce the volatility of yuan and ruble exchange rates. The clearing center is one of a range of measures the People’s Bank of China and the Russian Central Bank have been looking at to deepen their co-operation,Sputnik reported.

One of the most significant measures under consideration is the previouslyreported push for joint organization of trade in gold. In recent years, China and Russia have been the world’s most active buyers of the precious metal. On a visit to China last year, the deputy head of the Russian Central Bank Sergey Shvetsov said that the two countries want to facilitate more transactions in gold between the two countries.

“We discussed the question of trade in gold. BRICS countries are large economies with large reserves of gold and an impressive volume of production and consumption of this precious metal. In China, the gold trade is conducted in Shanghai, in Russia it is in Moscow. Our idea is to create a link between the two cities in order to increase trade between the two markets,” First Deputy Governor of the Russian Central Bank Sergey Shvetsov toldRussia’s TASS news agency.

In other words, China and Russia are shifting away from dollar-based trade, to commerce which will eventually be backstopped by gold, or what is gradually emerging as an Eastern gold standard, one shared between Russia and China, and which may day backstop their respective currencies.

Meanwhile, the price of gold continues to reflect none of these potentially tectonic strategic shifts, just as China – which has been the biggest accumulator of gold in recent years – likes it.

Like this:

Summary

The Russian central bank sees several catalysts that could stop the oil rally in its tracks.

Bearish rig count report from Baker Hughes could signal a reverse in direction.

Supply will continue to increase rather than slow down in 2016 – even if there is a decline in shale production.

Battle for market share is one of the major catalysts not being considered.

I believe it’s very clear this oil rally is running on fumes and was never the result of an improvement in fundamentals. That means to me this rally is going to quickly run out of steam if it isn’t able to run up quicker on existing momentum. I don’t see that happening, and it could pull back dramatically, catching a lot of investors by surprise. The Russian central bank agrees, saying it doesn’t believe the price of oil is sustainable under existing market conditions.

Cited by CNBC, the Russian central bank said, “the current oil market still features a continued oversupply, on the backdrop of a slowdown in the Chinese economy, more supplies originating from Iran and tighter competition for market share.”

In other words, most things in the market that should be improving to support the price of oil aren’t. That can only mean one thing: a violent pullback that could easily push the price of oil back down to the $30 to $32 range. If the price starts to fall quickly, we could see panic selling driving the price down even further.

I think most investors understand this is not a legitimate rally when looking at the lack of change in fundamentals. I’ll be glad when the production freeze hoax is seen for what it is: a manipulation of the price of oil by staggered press releases meant to pull investors along for the ride. The purpose is to buy some time to give the market more time to rebalance. Once this is seen for what it really is, oil will plummet. It could happen at any time in my opinion.

Rig count increases for first time in three months

For the first time in three months, the U.S. rig count was up, increasing by one to 387. By itself this isn’t that important, but when combined with the probability that more shale supply may be coming to the market in 2016, it definitely could be an early sign of the process beginning.

EOG Resources (NYSE:EOG) has stated it plans on starting up to 270 wells in 2016. We don’t know yet how much additional supply it represents, but it’s going to offset some of the decline from other companies that can’t continue to produce at these price levels. There are other low-cost shale producers that may be doing the same, although I think the price of oil will have to climb further to make it profitable for them, probably around $45 per barrel.

It’s impossible to know at this time if the increase in the price of oil was a catalyst, or we’ve seen the bottom of the drop in rig counts. The next round of earnings reports will give a glimpse into that.

Fundamentals remain weak

Most of the recent strength of the price of oil has been the continual reporting on the proposed production freeze from OPEC and Russia. This is light of the fact there really won’t be a freeze, even if a piece of paper is signed saying there is.

We know Iran isn’t going to agree to a freeze, and with Russia producing at post-Soviet highs and Iraq producing at record levels, what would a freeze mean anyway? It would simply lock in output levels the countries were going to operate at with or without an agreement.

The idea is the freeze is having an effect on the market and this will lead to a production cut. That simply isn’t going to happen. There is zero chance of that being the outcome of a freeze, if that ever comes about.

And a freeze without Iran isn’t a freeze. To even call it that defies reality. How can there be a freeze when the one country that would make a difference isn’t part of it? If Iran doesn’t freeze production, it means more supply will be added to the market until it reaches pre-sanction levels. At that time, all Iran has promised is it may consider the idea.

What does that have to do with fundamentals? Absolutely nothing. That’s the point.

Analysis and decisions need to be based on supply and demand. Right now that doesn’t look good. The other major catalyst pushing up oil prices has been the belief that U.S. shale production will decline significantly in 2016, which would help support oil. The truth is we have no idea to what level production will drop. It seems every time a report comes out it’s revised in a way that points to shale production remaining more resilient than believed.

I have no doubt there will be some production loss in the U.S., but to what degree there will be a decline, when considering new supply from low-cost shale companies, has yet to be determined. I believe it’s not going to be near to what was originally estimated, and that will be another element weakening support over the next year.

Competing for market share

One part of the oil market that has been largely ignored has been the competition for market share itself. When U.S. shale supply flooded the market, the response from Saudi Arabia was to not cede market share in any way. That is the primary reason for the plunge in oil prices.

There has been no declaration by the Saudis that they are going to change their strategy in relationship to market share and have said numerous times they are going to let the market sort it out, as far as finding a balance between supply and demand. So the idea they are now heading in a different direction is a fiction created by those trying to find anything to push up the price of oil.

It is apparent some of the reason for increased U.S. imports comes from Saudi Arabia in particular lowering its prices to nudge out domestic supply. It’s also why the idea of inventory being reduced in conjunction with lower U.S. production can’t be counted on. It looks like imports will continue to climb while shale production declines.

More competition means lower prices, although in this case, Saudi Arabia is selling its oil at different price points to different markets. It’s the average that matters there, and we simply don’t have the data available to know what that is.

In the midst of all of this, Russia is battling the Saudis for share in China, while the two also battle it out in parts of Europe, with Saudi Arabia looking to take share away from Russia. Some of Europe has opened up to competitors because it doesn’t want to rely too much on Russia as its major energy source.

For this and other competitive reasons, I could never trust a production freeze agreement if it ever came to fruition. They haven’t been adhered to in the past, and they won’t be if it happens again. Saudi Arabia has stated several times that it feels the same way.

Conclusion

To me the Russian central bank is spot on in saying the chance of a sustainable oil rally is slim. It also accurately pointed out the reasons for that: it’s about the lack of the fundamentals changing.

With U.S. inventory increasing, rig counts probably at or near a bottom, no end in sight to oversupply continuing, and competition for a low-demand market heating up, there is nothing I see that can justify an ongoing upward price move. I don’t even see it being able to hold.

A weaker U.S. dollar has legitimately helped some, but it can’t support the price of oil on its own. When all the other factors come together in the minds of investors, and the price of oil starts to reverse direction, there is a very strong chance a lot of bullish investors are going to get crushed hard. It is probably time to take some profits and run for the exit if you’re in the oil market for the short term.

Irrational Oil Optimists About To Experience Some Panic Selling Pain

Summary

U.S. production will outperform estimates as shale producers add supply to the market.

Inventory will come under more strain as key U.S. storage facilities approach full capacity.

Dollar weakness isn’t enough to maintain oil price momentum.

The longer the price of oil has upward momentum, and the higher it goes, the more risky it becomes for investors because there is nothing outside of a weakening U.S. dollar to justify any kind of move we’ve seen the price of oil make recently.

The falling dollar isn’t enough to keep the oil price from falling to where it belongs, and that means when the selloff begins, it’s likely to gravitate into full-panic mode, with sellers running for the exits before they get burned.

This is especially risky for those looking to make a quick windfall from the upward movement of oil. I’m not concerned about those taking long-term positions in quality energy companies with significant oil exposure, since they’ve probably enjoyed some great entry points. There is, of course, dividend risk, along with the strong probability of further share erosion before there is a real recovery that has legs to stand on because it’s based on fundamentals.

For that reason, investors should seriously consider taking profits off the table and wait for better conditions to re-enter.

Oil has become a fear play. Not the fear of losing money, but the fear of not getting in on the fast-moving action associated with the quick-rising price of oil. Whenever there is a fear play, it is ruled by emotion, and no amount of data will convince investors to abandon their giddy profits until they lose much, if not all, of what they gained. Don’t be one of them.

Having been a financial adviser in the past, I know what a lot of people are thinking at this time in response to what I just said. I’ve heard it many times before. It usually goes something like this: “What if the price of oil continues to rise and I lose a lot of money because of leaving the market too soon?” That’s a question arising from a fear mentality. The better question is this: “What if the oil price plunges and panic selling sets in?”

Oil is quickly becoming a casino play on the upside, and the longer investors stay in, the higher the probability they’ll lose the gains they’ve enjoyed. Worse, too much optimism could result in losses if preventative action isn’t taken quickly enough.

What needs to be considered is why one should stay in this market. What is so convincing it warrants this type of increasing risk, which offers much less in the way of reward than even a week ago? What fundamentals are in place that suggest a sustainable upward movement in the price of oil? The answer to those questions will determine how oil investors fare in the near future.

U.S. shale production

The more I think on the estimates associated with U.S. shale production in 2016, measured against the statements made by stronger producers that they’re going to boost supply from premium wells this year, the more I’m convinced it isn’t going to fall as much as expected. New supply will offset a lot of the less productive and higher cost wells being shuttered. I do believe there will be some loss of production from that, but not as much as is being suggested.

There are various predictions on how much production is going to be lost, but the general consensus is from 300,000 bpd to 600,000 bpd. It could come in on the lower side of that estimate, but I don’t think it’ll be close to the upper end of the estimate.

What is unknown because we don’t have an historical guideline to go by is, the amount of oil these premium wells will add to supply. We also don’t know if the stated goals will be followed up on. I think they will, but we won’t know for certain until the next couple of earnings reports give a clearer picture.

When combined with the added supply coming from Iran, and the ongoing high levels of production from Saudi Arabia, Russia and Iraq, I don’t see how the current support for the price of oil can continue on for any length of time.

There is no way of knowing exactly when the price of oil will once again collapse, but the longer it stays high without a change in the fundamentals, the higher the risk becomes, and the more chance it could swing the other way on momentum, even if it isn’t warranted. It could easily test the $30 mark again under those conditions.

Inventory challenges

What many investors don’t understand about storage and inventory is it definitely matters where the challenges are located. That’s why Cushing being over 90 percent capacity and Gulf storage only a little under 90 percent capacity means more than if other facilities were under similar pressure. Together, they account for over 60 percent of U.S. storage.

With the imbalance of supply and demand driving storage capacity levels, the idea of oil staying above $40 per barrel for any period of time is highly unlikely. A lower U.S. dollar and the highly irrelevant proposed production freeze talks can’t balance it off.

Once the market digests this, which could happen at any time, we’ll quickly enter bear mode again. The problem is the price of oil is straining against its upper limits, and if momentum starts to deflate, the race to sell positions will become a sprint and not a marathon.

Uncertainty about shale is the wild card

As already mentioned, U.S. shale production continues to be the major catalyst to watch. The problem is we have no way of knowing what has already been unfolding in the first quarter. If investors start to abandon their positions, and we find shale supply is stronger than projected, it’ll put further downward pressure on oil after it has already corrected.

What I mean by that is we should experience some fleeing from oil before the next earnings reports from shale producers are released. If the industry continues to surprise on the upside of supply, it’ll cause the price of oil to further deteriorate, making the outlook over the next couple of months potentially ominous.

This isn’t just something that has a small chance of happening; it’s something that has a very strong probability of happening. Agencies like IEA have already upwardly revised their outlook for shale supply in 2016, and if that’s how it plays out, the entire expected performance for the year will have to be adjusted.

Conclusion

Taking into account the more important variables surrounding what will move the price of oil, shale production remains the most important information to follow. Not much else will matter if supply continues to exceed expectations. It will obliterate all the models and force analysts to admit this has little to do with prior supply cycles and everything to do with a complete market disruption. Many are still in denial of this. They’ll learn the reality soon enough.

That doesn’t mean there won’t eventually be a time when demand finally catches up with supply, but within the parameters of this weak global economy and oil supply that continues to grow, it’s going to take a lot longer to realize than many thought.

For several months, it has been understood that the market underestimated the expertise and efficiency of U.S. shale producers, and to this day they continue to do so. We will find out if that remains in play in the first half of 2016, and by then, whether it’ll extend further into 2017.

As for how it will impact the price of oil now, if we start to have some panic selling before the earnings reports, and the earnings reports of the important shale producers exceed expectations on the supply side, with it being reflected in an increase in the overall output estimates for the year, it will put more downward pressure on oil.

The other scenario is oil lingers around $40 per barrel until the earnings reports come out. There will still be a decline in the price of oil, the level of which would depend on how much more supply shale producers brought to the market in the first quarter than expected.

My thought is we’re going to experience a drop in the price of oil before earnings reports, which then could trigger a secondary exodus from investors in it for short-term gains.

For those having already generated some decent returns, it may be time to take it off the table. I don’t see how the shrinking reward can justify the growing risk.

Summary

The Mosul Dam in Iraq could collapse at any time, causing massive flooding across the country.

Iraq produces over four million barrels of oil per day, a number which will drop immediately when this event occurs.

The destruction of oil production in Iraq will immediately decrease world supply, lifting oil prices.

The Oil Situation: Since 2014, the oil market has been in a tailspin due to a multitude of global factors. As of March 2016, prices seem to have stabilized, although the persistence of crude oversupply continues to hang over the market. For months, declining US production and a potential output freeze by OPEC have been putting a potential floor in place. However, I believe an event is on the horizon which will change the equilibrium of oil prices immediately… the collapse of the Mosul Dam.

The Mosul Dam:The Mosul Dam is the largest dam in Iraq. It is located on the Tigris River in the western governance of Ninawa, upstream of the city of Mosul. Constructed in 1981, the dam has had a history of structural issues, requiring perpetual maintenance in order to maintain its integrity. Since 1984, this consisted of 300 man crews, working 24 hours a day across three shifts, filling holes in the bedrock through a process called grouting. For 30 years, this process worked, although it was always considered to be a ticking time bomb, dubbed “the most dangerous dam in the world” by the US Army Corps of Engineers.

In August 2014, the Islamic State of Iraq and the Levant took control of the dam, halting the maintenance process until it was retaken by Iraqi, Kurdish and US Forces two weeks later. Unfortunately, the damage was already done… since then, the maintenance crews have been limited to 30 personnel or less, and the equipment is inadequate to continue patching holes. Per the dam’s former chief engineer, Nasrat Adamo, “The machines for grouting have been looted. There is no cement supply. They can do nothing. It is going from bad to worse, and it is urgent. All we can do is hold our hearts.” As winter snows melt, the water levels will rise to unsustainable levels, and while it has two pressure release gates to avoid this scenario, one has been non-functioning for years, and using the second one alone risks the stability of the structure.

The Event: When the Mosul Dam collapses (and without reconstruction measures being implemented quickly, this is considered a ‘when’, not an ‘if’), a wave 45-65 feet high is expected to flood the country, drowning Mosul in four hours and reaching Baghdad within two to four days.

Estimates range from 500,000 to 1,500,000 lives lost. In addition to flooding, there will be secondary and tertiary effects… as demonstrated in America during Hurricane Katrina, panic and lawlessness can be equally as dangerous as the flooding itself, but even worse, diseases such as malaria and West Nile fever will follow. A catastrophic event of this magnitude will immediately push the entire country into chaos, and Iraq does not have the capability to respond without global support. The closest comparison to make is Haiti, which with billions in global assistance has not returned to normalcy in five years. Overall, I anticipate this catastrophe will take years to overcome… in the meantime, it will have a significant effect on the world’s supply of oil today.

The Effects:As of winter 2015, Iraq was producing 4.3M barrels per day, with the southern fields producing 3.3M barrels and the remaining 1M coming from the north. The graphic below (left) is from 2014, but gives a picture of the oil field placements. To the right is a topographical map, which gives us an idea of how the floodwaters will progress. Based on the elevation of where the flood would initiate, everything between Mosul and Baghdad will be completely covered, and while the wave will dissipate over time, the fields between Baghdad and Basra will see enough water (and everything that comes with it, to include bodies, disease and unexploded ordinance) to temporarily disable operations. Additionally, the pipeline between Kirkuk and Ramadi will be underwater, and there is a potential for damage to the Iraq Strategic Pipeline, which runs parallel to the direction of the water’s progression.

The world’s oversupply of oil is estimated around one million barrels per day. Assume that the above happens, and in a best-case scenario, only northern production is affected. What would occur immediately is the elimination of one quarter of Iraq’s oil output, rapidly pushing supply and demand into equilibrium. In a worst-case scenario, where all of Iraq’s oil is temporarily eliminated, it will move the supply deficit to three million barrels per day, leading to large ramifications on the world’s crude oil surplus within weeks.

While the true answer lies somewhere between these possibilities, what is undeniable is that a catastrophe of this magnitude will immediately move the price of crude oil up, and depending on the timeline to return to today’s production levels, that move could be enormous. In late 2015, the world produced 97M barrels per day, causing the price to collapse to $26.00 per barrel. In 2014, while producing 93M barrels per day, the price averaged near $110.00 prior to its fall. Although the above is simple extrapolation, demand continues to grow, so I think we can all agree that the price shift north will be significant.

Conclusion: The subject of this article is admittedly morbid. The true fallout of this event is the loss of hundreds of thousands of Iraqi lives, and damage that would take years to erase. However, as informed investors, it would be irresponsible to not consider global events, and this has the potential to re-balance the oil market in a matter of days. When this occurs, over four million barrels per day can disappear from production, immediately shifting the direction of oil prices. Based on the above information, I believe a production cut decision by OPEC is irrelevant, as natural forces are preparing to address the oil oversupply on their own.

Last week, during the peak of the commodity short squeeze, we pointed out how this default cycle is shaping up to be vastly different from previous one: recovery rates for both secured and unsecured debts are at record low levels. More importantly, we noted how this notable variance is impacting lender behavior, explaining that banks – aware that the next leg lower in commodities is imminent – are not only forcing the squeeze in the most trashed stocks (by pulling borrow) but are doing everything in their power to “assist” energy companies to sell equity, and use the proceeds to take out as much of the banks’ balance sheet exposure as possible, so that when the default tsunami finally arrives, banks will be as far away as possible from the carnage. All of this was predicated on prior lender conversations with the Dallas Fed and the OCC, discussions which the Dallas Fed vocally denied accusing us of lying, yet which the WSJ confirmed, confirming the Dallas Fed was openly lying.

This was the punchline:

[Record low] recovery rate explain what we discussed earlier, namely the desire of banks to force an equity short squeeze in energy stocks, so these distressed names are able to issue equity with which to repay secured loans to banks who are scrambling to get out of the capital structure of distressed E&P names. Or as MatlinPatterson’s Michael Lipsky put it: “we always assume that secured lenders would roll into the bankruptcy become the DIP (debtor in possession) lenders, emerge from bankruptcy as the new secured debt of the company. But they don’t want to be there, so you are buying the debt behind them and you could find yourself in a situation where you could lose 100% of your money.“

And so, one by one the pieces of the puzzle fall into place: banks, well aware that they are facing paltry recoveries in bankruptcy on their secured exposure (and unsecured creditors looking at 10 cents on the dollar), have engineered an oil short squeeze via oil ETFs…

… to take advantage of panicked investors some of whom are desperate to cover their shorts, and others who are just as desperate to buy the new equity issued. Those proceeds, however, will not go to organic growth or even to shore liquidity but straight to the bank to refi loan facilities and let banks, currently on the hook, leave silently by the back door. Meanwhile, the new investors have no security claims and zero liens, are at the very bottom of the capital structure, and face near certain wipe outs.

In short, once the current short squeeze is over, expect everyone to start paying far more attention to recovery rates and the true value of “fundamentals.”

Going back to what Lipsky said, “the banks do not want to be there.” So where do they want to be? As far away as possible from the shale carnage when it does hit.

Today, courtesy of The New York Shock Exchange, we present just the case study demonstrating how this takes place in the real world. Here the story of troubled energy company “Lower oil prices for longer” Weatherford, its secured lender JPM, the incestuous relationship between the two, and how the latter can’t wait to get as far from the former as possible, in…

I am on record saying that Weatherford International is so highly-leveraged that it needs equity to stay afloat. With debt/EBITDA at 8x and $1 billion in principal payments coming due over the next year, the oilfield services giant is in dire straits. Weatherford has been in talks with JP Morgan Chase to re-negotiate its revolving credit facility — the only thing keeping the company afloat. However, in a move that shocked the financial markets, JP Morgan led an equity offering that raised $565 million for Weatherford. Based on liquidation value Weatherford is insolvent. The question remains, why would JP Morgan risk its reputation by selling shares in an insolvent company?

According to the prospectus, at Q4 2015 Weatherford had cash of $467 million debt of $7.5 billion. It debt was broken down as follows: [i] revolving credit facility ($967 million), [ii] other short-term loans ($214 million), [iii] current portion of long-term debt of $401 million and [iv] long-term debt of $5.9 billion. JP Morgan is head of a banking syndicate that has the revolving credit facility.

Even in an optimistic scenario I estimate Weatherford’s liquidation value is about $6.7 billion less than its stated book value. The lion’s share of the mark-downs are related to inventory ($1.1B), PP&E ($1.9B), intangibles and non-current assets ($3.5B). The write-offs would reduce Weatherford’s stated book value of $4.4 billion to – $2.2 billion. After the equity offering the liquidation value would rise to -$1.6 billion.

JP Morgan and Morgan Stanley also happen to be lead underwriters on the equity offering. The proceeds from the offering are expected to be used to repay the revolving credit facility.

In effect, JP Morgan is raising equity in a company with questionable prospects and using the funds to repay debt the company owes JP Morgan. The arrangement allows JP Morgan to get its money out prior to lenders subordinated to it get their $401 million payment. That’s smart in a way. What’s the point of having a priority position if you can’t use that leverage to get cashed out first before the ship sinks? The rub is that [i] it might represent a conflict of interest and [ii] would JP Morgan think it would be a good idea to hawk shares in an insolvent company if said insolvent company didn’t owe JP Morgan money?

The answer? JP Morgan doesn’t care how it looks; JP Morgan wants out and is happy to do it while algos and momentum chasing day traders are bidding up the stock because this time oil has finally bottomed… we promise.

So here’s the good news: as a result of this coordinated lender collusion to prop up the energy sector long enough for the affected companies to sell equity and repay secured debt, the squeeze may last a while; as for the bad news: the only reason the squeeze is taking place is because banks are looking to get as far from the shale patch and the companies on it, as possible.

We leave it up to readers to decide which “news” is more relevant to their investing strategy.

The law of supply states that the quantity of a good supplied rises as the market price rises, and falls as the price falls. Conversely, the law of demand states that the quantity of a good demanded falls as the price rises, and vice versa.

These basic laws of supply and demand are the fundamental building blocks of how we arrive at a given price for a given product.

At least, that’s how it’s supposed to work.

But what if I told you that the principles you grew up learning is wrong?

With today’s “creative” financial instruments, much of what you learned no longer applies in the real world.

“On September 11, Saudi Arabia finally inked a deal with the U.S. to drop bombs on Syria.

But why?

Saudi Arabia possesses 18 per cent of the world’s proven petroleum reserves and ranks as the largest exporter of petroleum.

Syria is home to a pipeline route that can bring gas from the great Qatar natural gas fields into Europe, making billions of dollars for Saudi Arabia as the gas moves through while removing Russia’s energy stronghold on Europe.

Could the U.S. have persuaded Saudi Arabia, during their September 11 meeting, to lower the price of oil in order to hurt Russia, while stimulating the American economy?

… On October 1, 2014, shortly after the U.S. dropped bombs on Syria on September 26 as part of the September 11 agreement, Saudi Arabia announced it would be slashing prices to Asian nations in order to “compete” for crude market share. It also slashed prices to Europe and the United States.”

Following Saudi Arabia’s announcement, oil prices have plunged to a level not seen in more than five years.

Is it a “coincidence” that shortly after the Saudi Arabia-U.S. meeting on the coincidental date of 9-11, the two nations inked a deal to drop billions of dollars worth of bombs on Syria? Then just a few days later, Saudi Arabia announces a massive price cut to its oil.

Coincidence?

There are many other factors – and conspiracies – in oil price manipulation, such as geopolitical attacks on Russia and Iran, whose economies rely heavily on oil. Saudi Arabia is also flooding the market with oil – and I would suggest that it’s because they are rushing to trade their oil for weapons to lead an attack or beef up their defense against the next major power in the Middle East, Iran.

However, all of the reasons, strategies or theories of oil price manipulation could only make sense if they were allowed by these two major players: the regulators and the Big Banks.

How Oil is Priced

On any given day, if you were to look at the spot price of oil, you’d likely be looking at a quote from the NYMEX in New York or the ICE Futures in London. Together, these two institutions trade most of the oil that creates the global benchmark for oil prices via oil futures contracts on West Texas Intermediate (WTI) and North Sea Brent (Brent).

What you may not see, however, is who is trading this oil, and how it is being traded.

Up until 2006, the price of oil traded within reason. But all of a sudden, we saw these major price movements. Why?

“Until recently, U.S. energy futures were traded exclusively on regulated exchanges within the United States, like the NYMEX, which are subject to extensive oversight by the CFTC, including ongoing monitoring to detect and prevent price manipulation or fraud.

In recent years, however, there has been a tremendous growth in the trading of contracts that look and are structured just like futures contracts, but which are traded on unregulated OTC electronic markets. Because of their similarity to futures contracts they are often called ”futures look-a likes.”

The only practical difference between futures look-alike contracts and futures contracts is that the look-a likes are traded in unregulated markets whereas futures are traded on regulated exchanges.

The trading of energy commodities by large firms on OTC electronic exchanges was exempted from CFTC oversight by a provision inserted at the behest of Enron and other large energy traders into the Commodity Futures Modernization Act of 2000 in the waning hours of the 106th Congress.

The impact on market oversight has been substantial.

NYMEX traders, for example, are required to keep records of all trades and report large trades to the CFTC. These Large Trader Reports (LTR), together with daily trading data providing price and volume information, are the CFTC’s primary tools to gauge the extent of speculation in the markets and to detect, prevent, and prosecute price manipulation.

…In contrast to trades conducted on the NYMEX, traders on unregulated OTC electronic exchanges are not required to keep records or file Large Trader Reports with the CFTC, and these trades are exempt from routine CFTC oversight.

In contrast to trades conducted on regulated futures exchanges, there is no limit on the number of contracts a speculator may hold on an unregulated OTC electronic exchange, no monitoring of trading by the exchange itself, and no reporting of the amount of outstanding contracts (”open interest”) at the end of each day.

The CFTC’s ability to monitor the U.S. energy commodity markets was further eroded when, in January of this year (2006), the CFTC permitted the Intercontinental Exchange (ICE), the leading operator of electronic energy exchanges, to use its trading terminals in the United States for the trading of U.S. crude oil futures on the ICE futures exchange in London-called ”ICE Futures.”

Previously, the ICE Futures exchange in London had traded only in European energy commodities-Brent crude oil and United Kingdom natural gas. As a United Kingdom futures market, the ICE Futures exchange is regulated solely by the United Kingdom Financial Services rooority. In 1999, the London exchange obtained the CFTC’s permission to install computer terminals in the United States to permit traders here to trade European energy commodities through that exchange.

Then, in January of this year, ICE Futures in London began trading a futures contract for West Texas Intermediate (WTI) crude oil, a type of crude oil that is produced and delivered in the United States. ICE Futures also notified the CFTC that it would be permitting traders in the United States to use ICE terminals in the United States to trade its new WTI contract on the ICE Futures London exchange.

Beginning in April, ICE Futures similarly allowed traders in the United States to trade U.S. gasoline and heating oil futures on the ICE Futures exchange in London. Despite the use by U.S. traders of trading terminals within the United States to trade U.S. oil, gasoline, and heating oil futures contracts, the CFTC has not asserted any jurisdiction over the trading of these contracts.

Persons within the United States seeking to trade key U.S. energy commodities-U.S. crude oil, gasoline, and heating oil futures-now can avoid all U.S. market oversight or reporting requirements by routing their trades through the ICE Futures exchange in London instead of the NYMEX in New York.

As an increasing number of U.S. energy trades occurs on unregulated, OTC electronic exchanges or through foreign exchanges, the CFTC’s large trading reporting system becomes less and less accurate, the trading data becomes less and less useful, and its market oversight program becomes less comprehensive.

The absence of large trader information from the electronic exchanges makes it more difficult for the CFTC to monitor speculative activity and to detect and prevent price manipulation. The absence of this information not only obscures the CFTC’s view of that portion of the energy commodity markets, but it also degrades the quality of information that is reported.

A trader may take a position on an unregulated electronic exchange or on a foreign exchange that is either in addition to or opposite from the positions the trader has taken on the NYMEX, and thereby avoid and distort the large trader reporting system.

Not only can the CFTC be misled by these trading practices, but these trading practices could render the CFTC weekly publication of energy market trading data, intended to be used by the public, as incomplete and misleading.”

Simply put, any one can now speculate and avoid being tagged with illegal price. The more speculative trading that occurs, the less “real” price discovery via true supply and demand become.

With that in mind, you can now see how the big banks have gained control and cornered the oil market.

Continued from the Report:

“…Over the past few years, large financial institutions, hedge funds, pension funds, and other investment funds have been pouring billions of dollars into the energy commodities markets…to try to take advantage of price changes or to hedge against them.

Because much of this additional investment has come from financial institutions and investment funds that do not use the commodity as part of their business, it is defined as ”speculation” by the Commodity Futures Trading Commission (CFTC).

…Reports indicate that, in the past couple of years, some speculators have made tens and perhaps hundreds of millions of dollars in profits trading in energy commodities.

This speculative trading has occurred both on the regulated New York Mercantile Exchange (NYMEX) and on the over-the-counter (OTC) markets.

The large purchases of crude oil futures contracts by speculators have, in effect, created an additional demand for oil, driving up the price of oil to be delivered in the future in the same manner that additional demand for the immediate delivery of a physical barrel of oil drives up the price on the spot market.

As far as the market is concerned, the demand for a barrel of oil that results from the purchase of a futures contract by a speculator is just as real as the demand for a barrel that results from the purchase of a futures contract by a refiner or other user of petroleum.

Although it is difficult to quantify the effect of speculation on prices, there is substantial evidence that the large amount of speculation in the current market has significantly increased prices.

Several analysts have estimated that speculative purchases of oil futures have added as much as $20-$25 per barrel to the current price of crude oil, thereby pushing up the price of oil from $50 to approximately $70 per barrel.”

The biggest banks in the world, such as Goldman Sachs, Morgan Stanley, Citigroup, JP Morgan, are now also the biggest energy traders; together, they not only participate in oil trades, but also fund numerous hedge funds that trade in oil.

Knowing how easy it is to force the price of oil upwards, the same strategies can be done in reverse to force the price of oil down.

All it takes is for some media-conjured “report” to tell us that Saudi Arabia is flooding the market with oil, OPEC is lowering prices, or that China is slowing, for oil to collapse.

Traders would then go short oil, kicking algo-traders into high gear, and immediately sending oil down further. The fact that oil consumption is actually growing really doesn’t matter anymore.

In reality, oil price isn’t dictated by supply and demand – or OPEC, or Russia, or China – it is dictated by the Western financial institutions that trade it.

The Reason is Manipulation, the Question is Why?

“For years, I have been talking about how the banks have taken control of our civilization.

…With oil prices are falling, economies around the world are beginning to feel the pain causing a huge wave of panic throughout the financial industry. That’s because the last time oil dropped like this – more than US$40 in less than six months – was during the financial crisis of 2008.

…Let’s look at the energy market to gain a better perspective.

The energy sector represents around 17-18 percent of the high-yield bond market valued at around $2 trillion.

Over the last few years, energy producers have raised more than a whopping half a trillion dollars in new bonds and loans with next to zero borrowing costs – courtesy of the Fed.

This low-borrowing cost environment, along with deregulation, has been the goose that laid the golden egg for every single energy producer. Because of this easy money, however, energy producers have become more leveraged than ever; leveraging themselves at much higher oil prices.

But with oil suddenly dropping so sharply, many of these energy producers are now at serious risk of going under.

In a recent report by Goldman Sachs, nearly $1 trillion of investments in future oil projects are at risk.

…It’s no wonder the costs of borrowing for energy producers have skyrocketed over the last six months.

…many of the companies are already on the brink of default, and unable to make even the interest payments on their loans.

…If oil continues in this low price environment, many producers will have a hard time meeting their debt obligations – meaning many of them could default on their loans. This alone will cause a wave of financial and corporate destruction. Not to mention the loss of hundreds of thousands of jobs across North America.”

You may be thinking, “if oil’s fall is causing a wave of financial disaster, why would the banks push the price of oil down? Wouldn’t they also suffer from the loss?”

Great question. But the banks never lose. Continued from my letter:

“If you control the world’s reserve currency, but slowly losing that status as a result of devaluation and competition from other nations (see When Nations Unite Against the West: The BRICS Development Bank), what would you do to protect yourself?

You buy assets. Because real hard assets protect you from monetary inflation.

With the banks now holding record amounts of highly leveraged paper from the Fed, why would they not use that paper to buy hard assets?

Bankers may be greedy, but they’re not stupid.

The price of hard physical assets is the true representation of inflation.

Therefore, if you control these hard assets in large quantities, you could also control their price.

This, in turn, means you can maintain control of your currency against monetary inflation.

And that is exactly what the banks have done.

The True World Power

Last month, the U.S. Senate’s Permanent Subcommittee on Investigations published a 403-page report on how Wall Street’s biggest banks, such as Goldman Sachs, Morgan Stanley, and JP Morgan, have gained ownership of a massive amount of commodities, food, and energy resources.

The report stated that “the current level of bank involvement with critical raw materials, power generation, and the food supply appears to be unprecedented in U.S. history.”

For example:

“…Until recently, Morgan Stanley controlled over 55 million barrels of oil storage capacity, 100 oil tankers, and 6,000 miles of pipeline. JPMorgan built a copper inventory that peaked at $2.7 billion, and, at one point, included at least 213,000 metric tons of copper, comprising nearly 60% of the available physical copper on the world’s premier copper trading exchange, the LME.

In 2012, Goldman owned 1.5 million metric tons of aluminum worth $3 billion, about 25% of the entire U.S. annual consumption. Goldman also owned warehouses which, in 2014, controlled 85% of the LME aluminum storage business in the United States.” – Wall Street Bank Involvement with Physical Commodities, United States Senate Permanent Subcommittee on Investigations

From pipelines to power plants, from agriculture to jet fuel, these too-big-to-fail banks have amassed – and may have manipulated the prices – of some of the world’s most important resources.

The above examples clearly show just how much influence the Big Banks have over our commodities through a “wide range of risky physical commodity activities which included, at times, producing, transporting, storing, processing, supplying, or trading energy, industrial metals, or agricultural commodities.”

With practically an unlimited supply of cheap capital from the Federal Reserve, the Big Banks have turned into much more than lenders and facilitators. They have become direct commerce competitors with an unfair monetary advantage: free money from the Fed.

Of course, that’s not their only advantage.

According to the report, the Big Banks are engaging in risky activities (such as ownership in power plants and coal mining), mixing banking and commerce, affecting prices, and gaining significant trading advantages.

Just think about how easily it would be for JP Morgan to manipulate the price of copper when they – at one point – controlled 60% of the available physical copper on the world’s premier copper trading exchange, the LME.

How easy would it be for Goldman to control the price of aluminum when they owned warehouses – at one point – that controlled 85% of the LME aluminum storage business in the United States?

And if they could so easily control such vast quantities of hard assets, how easy would it be for them to profit from going either short or long on these commodities?

Always a Winner

But if, for some reason, the bankers’ bets didn’t work out, they still wouldn’t lose.

That’s because these banks are holders of trillions of dollars in FDIC insured deposits.

In other words, if any of the banks’ pipelines rupture, power plants explode, oil tankers spill, or coal mines collapse, taxpayers may once again be on the hook for yet another too-big-to-fail bailout.

If you think that there’s no way that the government or the Fed would allow this to happen again after 2008, think again.

Via the Guardian:

“In a small provision in the budget bill, Congress agreed to allow banks to house their trading of swaps and derivatives alongside customer deposits, which are insured by the federal government against losses.

The budget move repeals a portion of the Dodd-Frank financial reform act and, some say, lays the groundwork for future bailouts of banks who make irresponsibly risky trades.”

Recall from my past letters where I said that the Fed wants to engulf you in their dollars. If yet another bailout is required, then the Fed would once again be the lender of last resort, and Americans will pile on the debt it owes to the Fed.

It’s no wonder that in the report, it actually notes that the Fed was the facilitator of this sprawl by the banks:

“Without the complementary orders and letters issued by the Federal Reserve, many of those physical commodity activities would not otherwise have been permissible ‘financial’ activities under federal banking law. By issuing those complementary orders, the Federal Reserve directly facilitated the expansion of financial holding companies into new physical commodity activities.”

The Big Banks have risked tons of cash lending and facilitating in oil business. But in reality they haven’t risked anything. They get free money from the Fed, and since they aren’t supposed to be directly involved in natural resources, they obtain control in other ways.

Remember, the big banks – and ultimately the Fed who controls them – are the ones who truly control the world. Their monetary actions are the cause of many of the world’s issues and have been used for many years to maintain control of other nations and the world’s resources.

But they can’t simply go into a country, put troops on the ground and take over. No, that would be inhumane.

“Currency manipulation allows developed countries to print and lend to other developing countries at will.

A rich nation might go into a developing nation and lend them millions of dollars to build bridges, schools, housing, and expand their military efforts. The rich nation convinces the developing nation that by borrowing money, their nation will grow and prosper.

However, these deals are often negotiated at a very specific and hefty cost; the lending nation might demand resources or military and political access. Of course, developing nations often take the loans, but never really have the chance to pay it back.

When the developing nations realize they can’t pay back the loans, they’re at the mercy of the lending nations.

The trick here is that the lending nations can print as much money as they want, and in turn, control the resources of developing nations. In other words, the loans come at a hefty cost to the borrower, but at no cost to the lender.”

This brings us back to oil.

We know that oil’s crash has put a heavy burden on many debt facilities that are associated with oil. We also know that the big banks are all heavily leveraged within the sector.

If that is the case, why are the big banks so calm?

The answer is simple.

Asset-Backed Lending

Most of the loans associated with oil are done through asset-backed loans, or reserve-based financing.

It means that the loans are backed by the underlying asset itself: the oil reserves.

So if the loans go south, guess who ends up with the oil?

According to Reuters, JP Morgan is the number one U.S. bank by assets. And despite its energy exposure assumed at only 1.6 percent of total loans, the bank could own reserves of up to $750 million!

As oil collapses and defaults arise, the banks have not only traded dollars for assets on the cheap, but gained massive oil reserves for pennies on the dollar to back the underlying contracts of the oil that they so heavily trade.

The argument to this would be that many emerging markets have laws in place that prevent their national resources from being turned over to foreign entities in the case of corporate defaults.

‘Brazilian state-run oil company Petróleo Brasileiro SA said Tuesday (September 22, 2015) it is closing a deal to sell natural-gas distribution assets to a local subsidiary of Japan’s Mitsui & Co.’

The combination of monetary policy and commodities manipulation allows Western banks and allies to accumulate hard assets at the expense of emerging markets. And this has been exactly the plan since day one.

As the Fed hints of raising rates, financial risks among emerging markets will continue to build. This will trigger a reappraisal of sovereign and corporate risks leading to big swings in capital flows.”

Not only are many of the big banks’ practices protected by government and Fed policies, but they’re also protected by the underlying asset itself. If things go south, the bank could end up owning a lot of oil reserves.

No wonder they’re not worried.

And since the banks ultimately control the price of oil anyway, it could easily bring the price back up when they’re ready.

Controlling the price of oil gives U.S. and its banks many advantages.

For example, the U.S. could tell the Iranians, the Saudis, or other OPEC nations, whose economies heavily rely on oil, “Hey, if you want higher oil prices, we can make that happen. But first, you have to do this…”

You see how much control the U.S., and its big banks, actually have?

At least, for now anyway.

Don’t think for one second that nations around the world don’t understand this.

Just ask Venezuela, and many of the other countries that have succumbed to the power of the U.S. Many of these countries are now turning to China because they feel they have been screwed.

The World Shift

The diversification away from the U.S. dollar is the first step in the uprising against the U.S. by other nations.

As the power of the U.S. dollar diminishes, through international currency swaps and loans, other trading platforms that control the price of commodities (such as the new Shanghai Oil Exchange) will become more prominent in global trade; thus, bringing some price equilibrium back to the market.

Chinese President Xi Jinping returned home Sunday after wrapping up a historic trip to Saudi Arabia, Egypt, and Iran with a broad consensus and 52 cooperation agreements set to deepen Beijing’s constructive engagement with the struggling yet promising region.

During Xi’s trip, China upgraded its relationship with both Saudi Arabia and Iran to a comprehensive strategic partnership and vowed to work together with Egypt to add more values to their comprehensive strategic partnership.

Regional organizations, including the Organization of Islamic Cooperation (OIC), the Cooperation Council for the Arab States of the Gulf (GCC) and the Arab League (AL), also applauded Xi’s visit and voiced their readiness to cement mutual trust and broaden win-win cooperation with China.

AL Secretary General Nabil al-Arabi said China has always stood with the developing world, adding that the Arab world is willing to work closely with China in political, economic as well as other sectors for mutual benefit.

The Belt and Road Initiative, an ambitious vision Xi put forward in 2013 to boost inter-connectivity and common development along the ancient land and maritime Silk Roads, has gained more support and popularity during Xi’s trip.

…Xi and leaders of the three nations agreed to align their countries’ development blueprints and pursue mutually beneficial cooperation under the framework of the Belt and Road Initiative, which comprises the Silk Road Economic Belt and the 21st Century Maritime Silk Road.

The initiative, reiterated the Chinese president, is by no means China’s solo, but a symphony of all countries along the routes, including half of the OIC members.

During Xi’s stay in Saudi Arabia, China, and the GCC resumed their free trade talks and “substantively concluded in principle the negotiations on trade in goods.” A comprehensive deal will be made within this year.”

In other words, the big power players in the Middle East – who produce the majority of the world’s oil – are now moving closer to cooperation with China, and away from the U.S.

As this progresses, it means the role of the U.S. dollar, and its value in world trade, will diminish.

And the big banks, which hold trillions of dollars in U.S. assets, aren’t concerned.

Earlier this week, before first JPM and then Wells Fargo revealed that not all is well when it comes to bank energy loan exposure, a small Tulsa-based lender, BOK Financial, said that its fourth-quarter earnings would miss analysts’ expectationsbecause its loan-loss provisions would be higher than expected as a result of a single unidentified energy-industry borrower. This is what the bank said:

“A single borrower reported steeper than expected production declines and higher lease operating expenses, leading to an impairment on the loan. In addition, as we noted at the start of the commodities downturn in late 2014, we expected credit migration in the energy portfolio throughout the cycle and an increased risk of loss if commodity prices did not recover to a normalized level within one year. As we are now into the second year of the downturn, during the fourth quarter we continued to see credit grade migration and increased impairment in our energy portfolio. The combination of factors necessitated a higher level of provision expense.”

Another bank, this time the far larger Regions Financial, said its fourth-quarter charge-offs jumped $18 million from the prior quarter to $78 million, largely because of problems with a single unspecified energy borrower. More than one-quarter of Regions’ energy loans were classified as “criticized” at the end of the fourth quarter.

It didn’t stop there and as the WSJ added, “It’s starting to spread” according to William Demchak, chief executive of PNC Financial Services Group Inc. on a conference call after the bank’s earnings were announced. Credit issues from low energy prices are affecting “anybody who was in the game as the oil boom started,” he said. PNC said charge-offs rose in the fourth quarter from the prior quarter but didn’t specify whether that was due to issues in its relatively small $2.6 billion oil-and-gas portfolio.

Then, on Friday, U.S. Bancorp disclosed the specific level of reserves it holds against its $3.2 billion energy portfolio for the first time. “The reason we did that is that oil is under $30” said Andrew Cecere, the bank’s chief operating officer. What else will Bancorp disclose if oil drops below $20… or $10?

It wasn’t just the small or regional banks either: as we first reported, on Thursday JPMorgan did something it hasn’t done in 22 quarter: its net loan loss reserve increased as a result of a jump in energy loss reserves. On the earnings call, Jamie Dimon said that while he is not worried about big oil companies, his bank has started to increase provisions against smaller energy firms.

Then yesterday it was the turn of the one bank everyone had been waiting for, the one which according to many has the greatest exposure toward energy: Wells Fargo. To be sure, in order not to spook its investors, among whom most famously one Warren Buffet can be found, for Wells it was mostly “roses”, although even Wells had no choice but to set aside $831 million for bad loans in the period, almost double the amount a year ago and the largest since the first quarter of 2013.

What was laughable is that the losses included $118 million from the bank’s oil and gas portfolio, an increase of $90 million from the third quarter. Why laughable? Because that $90 million in higher oil-and-gas loan losses was on a total of $17 billion in oil and gas loans, suggesting the bank has seen a roughly 0.5% impairment across its loan book in the past quarter.

How could this be? Needless to say, this struck us as very suspicious because it clearly suggests that something is going on for Wells (and all of its other peer banks), to rep and warrant a pristine balance sheet, at least until a “digital” moment arrives when just like BOK Financial, banks can no longer hide the accruing losses and has to charge them off, leading to a stock price collapse.

Which brings us to the focus of this post: earlier this week, before the start of bank earnings season, before BOK’s startling announcement, we reported we had heard of a rumor that Dallas Fed members had met with banks in Houston and explicitly “told them not to force energy bankruptcies” and to demand asset sales instead.

We can now make it official, because moments ago we got confirmation from a second source who reports that according to an energy analyst who had recently met Houston funds to give his 1H16e update, one of his clients indicated that his firm was invited to a lunch attended by the Dallas Fed, which had previously instructed lenders to open up their entire loan books for Fed oversight; the Fed was shocked by what it had found in the non-public facing records. The lunch was also confirmed by employees at a reputable Swiss investment bank operating in Houston.

This is what took place: the Dallas Fed met with the banks a week ago and effectively suspended mark-to-market on energy debts and as a result no impairments are being written down. Furthermore, as we reported earlier this week, the Fed indicated “under the table” that banks were to work with the energy companies on delivering without a markdown on worry that a backstop, or bail-in, was needed after reviewing loan losses which would exceed the current tier 1 capital tranches.

In other words, the Fed has advised banks to cover up major energy-related losses.

Why the reason for such unprecedented measures by the Dallas Fed? Our source notes that having run the numbers, it looks like at least 18% of some banks commercial loan book are impaired, and that’s based on just applying the 3Q marks for public debt to their syndicate sums.

In other words, the ridiculously low increase in loss provisions by the likes of Wells and JPM suggest two things: i) the real losses are vastly higher, and ii) it is the Fed’s involvement that is pressuring banks to not disclose the true state of their energy “books.”

Naturally, once this becomes public, the Fed risks a stampeded out of energy exposure because for the Fed to intervene in such a dramatic fashion it suggests that the US energy industry is on the verge of a subprime-like blow up.

Putting this all together, a source who wishes to remain anonymous, adds that equity has been levitating only because energy funds are confident the syndicates will remain in size to meet net working capital deficits. Which is a big gamble considering that as we first showed ten days ago, over the past several weeks banks have already quietly reduced their credit facility exposure to at least 25 deeply distressed (and soon to be even deeper distressed) names.

However, the big wildcard here is the Fed: what we do not know is whether as part of the Fed’s latest “intervention”, it has also promised to backstop bank loan losses. Keep in mind that according to Wolfe Research and many other prominent investors, as many as one-third of American oil-and-gas producers face bankruptcy and restructuring by mid-2017 unless oil rebounds dramatically from current levels.

However, the reflexive paradox embedded in this problem was laid out yesterday by Goldman who explainedthat oil could well soar from here but only if massive excess supply is first taken out of the market, aka the “inflection phase.” In other words, for oil prices to surge, there would have to be a default wave across the US shale space, which would mean massive energy loan book losses, which may or may not mean another Fed-funded bailout of US and international banks with exposure to shale.

What does it all mean? Here is the conclusion courtesy of our source:

If revolvers are not being marked anymore, then it’s basically early days of subprime when mbs payback schedules started to fall behind. My question for bank eps is if you issued terms in 2013 (2012 reserves) at 110/bbl, and redetermined that revolver in 2014 ‎at 86, how can you be still in compliance with that same rating and estimate in 2016 (knowing 2015 ffo and shut ins have led to mechanically 40pc ffo decreases year over year and at least 20pc rebooting of pud and pdnp to 2p via suspended or cancelled programs). At what point in next 12 months does interest payments to that syndicate start to unmask the fact that tranch is never being recovered, which I think is what pva and mhr was all about.

Beyond just the immediate cash flow and stock price implications and fears that the situation with US energy is much more serious if it merits such an intimate involvement by the Fed, a far bigger question is why is the Fed once again in the a la carte bank bailout game, and how does it once again select which banks should mark their energy books to market (and suffer major losses), and which ones are allowed to squeeze by with fabricated marks and no impairment at all? Wasn’t the purpose behind Yellen’s rate hike to burst a bubble? Or is the Fed less than “macro prudential” when it realizes that pulling away the curtain on of the biggest bubbles it has created would result in another major financial crisis?

The Dallas Fed, whose new president Robert Steven Kaplan previouslyworked at Goldman Sachs for 22 years rising to the rank of vice chairman of investment banking, has not responded to our request for a comment as of this writing. ( source: ZeroHedge )

Fed Response

Over the weekend, we gave the Dallas Fed a chance to respond to a Zero Hedge story corroborated by at least two independent sources, in which we reported that Federal Reserve members had met with bank lenders with distressed loan exposure to the US oil and gas sector and, after parsing through the complete bank books, had advised banks to i) not urge creditor counterparties into default, ii) urge asset sales instead, and iii) ultimately suspend mark to market in various instances.

Moments ago the Dallas Fed, whose president since September 2015 is Robert Steven Kaplan, a former Goldman Sachs career banker who after 22 years at the bank rose to the rank of vice chairman of its investment bank group – an odd background for a regional Fed president – took the time away from its holiday schedule to respond to Zero Hedge.

We thank the Dallas Fed for their prompt attention to this important matter. After all, as one of our sources commented, “If revolvers are not being marked anymore, then it’s basically early days of subprime when MBS payback schedules started to fall behind.” Surely there is nothing that can grab the public’s attention more than a rerun of the mortgage crisis, especially if confirmed by the highest institution.

As such we understand the Dallas Fed’s desire to avoid a public reaction and preserve semantic neutrality by refuting “such guidance.”

That said, we fully stand by our story, and now that we have engaged the Dallas Fed we would like to ask several very important follow up questions, to probe deeper into a matter that is of significant public interest as well as to clear up any potential confusion as to just what “guidance” the Fed is referring to.

Has the Dallas Fed, or any other members and individuals of the Federal Reserve System, met with U.S. bank and other lender management teams in recent weeks/months and if so what was the purpose of such meetings?

Has the Dallas Fed, or any other members and individuals of the Federal Reserve System, requested that banks and other lenders present their internal energy loan books and loan marks for Fed inspection in recent weeks/months?

Has the Dallas Fed, or any other members and individuals of the Federal Reserve System, discussed options facing financial lenders, and other creditors, who have distressed credit exposure including but not limited to:

avoiding defaults on distressed debtor counter parties?

encouraging asset sales for distressed debtor counter parties?

advising banks to avoid the proper marking of loan exposure to market?

advising banks to mark loan exposure to a model framework, one created either by the creditors themselves or one presented by members of the Federal Reserve network?

avoiding the presentation of public filings with loan exposure marked to market values of counter party debt?

Was the Dallas Fed, or any other members and individuals of the Federal Reserve System, consulted before the January 15, 2016 Citigroup Q4 earnings call during which the bank refused to disclose to the public the full extent of its reserves related to its oil and gas loan exposure, as quoted from CFO John Gerspach:

“while we are taking what we believe to be the appropriate reserves for that, I’m just not prepared to give you a specific number right now as far as the amount of reserves that we have on that particular book of business. That’s just not something that we’ve traditionally done in the past.”

Furthermore, if the Dallas Fed, or any other members and individuals of the Federal Reserve system, were not consulted when Citigroup made the decision to withhold such relevant information on potential energy loan losses, does the Federal Reserve System believe that Citigroup is in compliance with its public disclosure requirements by withholding such information from its shareholders and the public?

If the Dallas Fed does not issue “such” guidance to banks, then what precisely guidance does the Dallas Fed issue to banks?

Since the Fed is an entity tasked with serving the public, and since it took the opportunity to reply in broad terms to our previous article, we are confident that Mr. Kaplan and his subordinates will promptly address these follow up concerns.

Finally, in light of this official refutation by the Dallas Fed, we are confident that disclosing the Fed’s internal meeting schedules is something the Fed will not object to, and we hereby request that Mr. Kaplan disclose all of his personal meetings with members of the U.S. and international financial system since coming to office, both through this article, and through a FOIA request we are submitting concurrently. (source: ZeroHedge)

Fed Scrambles as Oil ETN Premium Soars to New Highs

Over the weekend, Zero Hedge reported exclusively how the Dallas Fed is pulling strings behind the scenes to conceal the fallout from the oil market crash. By suspending mark-to-market on energy loans and distorting the accounting, they are postponing the inevitable as long as possible. The current situation is eerily reminiscent to the heyday of the mortgage market in 2007, when mortgage defaults started to pick up, and yet the credit default swaps that tracked them continued to decline, bringing losses to those brave enough to trade against the crowd.

Amidst the market chaos on Friday, a trader brought something strange to my attention. He asked me exactly what the hell was going on with this ETN he was watching. I took a closer look and was baffled. It took me awhile to put the pieces together. Then when I saw the story about mark-to-market being suspended, it all made sense.

Here is the daily premium for the last 6 months on the Barclays iPath ETN that tracks oil:

Initially, I thought this was merely a sign of retail desperation. As they faced devastating losses on their oil stocks, small investors turned to products like oil ETNs as they tried to grasp the elusive oil profits their financial adviser promised them a year ago. Oblivious to the cruel mechanics of ETNs, they piled in head first, in spite of the soaring premium to fair value. After all, Larry Fink is making the rounds to convince the small investor that ETFs are indeed safer than mutual funds. Because nothing says “safe” like buying an ETN that is 36% above its fair value.

Sure, there are differences between ETFs and ETNs, particularly regarding their solvency in the event of an issuer default, but the premium/discount problem plagues ETFs and ETNs alike. Nonetheless, widely trusted retail sources of investment information perpetuate the myth that ETNs do not have tracking errors.

I thought I had connected the dots on the Oil ETN story. It was just retail ignorance. Then I saw this comment from a Zero Hedge reader:

He had a point. On Friday, stocks were slammed, and the team known as 3:30 Ramp Capital was noticeably absent.

Summary:

The current stock market decline began with transportation stocks and small capitalization stocks severely under-performing the market.

Weakness then spread to the energy complex and high-yield bonds.

Yield focused stocks were the next to fall, with Kinder Morgan being the most prominent example.

Stalwarts like Apple and Gilead lost their momentum with the August 2015 decline and never regained their mojo.

In 2016, a slow motion crash is occurring in the stock market, and the price action has finally impacted the leading FANG stocks.

“Hysteria is impossible without an audience. Panicking by yourself is the same as laughing alone in an empty room. You feel really silly.” – Chuck Palahniuk

“Life is ten percent what you experience and ninety percent how you respond to it.” – Dorothy M. Neddermeyer

Introduction:

The stock market decline has gained momentum in 2016, and much like a runaway train, the current decline will be hard to stop, until the persistent overvaluations plaguing the stock market over this current bull market are corrected.

The correction that has caused the average stock in the United States to correct over 25%, thus far, started as an innocuous move down in global equities, outside of the depression enveloping the downtrodden emerging markets and commodities stocks, and then spread from transportation stocks to market leaders like biotechnology companies. The first wave down culminated in a gut-wrenching August 2015 sell-off that saw the Dow Jones Industrial Average (NYSEARCA:DIA) fall 1000 points at the open on August 24th, 2015. The panic was quickly brushed aside, but not forgotten, as market leading stocks made new highs in the fall of 2015.

That optimism, has given way to the reality that global quantitative easing has not provided the boost that its biggest supporters claimed. Now, everything is falling in tandem, and there is not much hope with the Fed nearly out of bullets, other than perhaps lower energy prices, to spark a true recovery.

The financial markets have taken notice, and are repricing assets accordingly. Just like forays to the upside are not one way affairs, the move down will not be a one-way adjustment, and investors should be prepared for sharp counter-trend rallies, and the price action yesterday, Thursday, January 14th, 2016 is a perfect example. To close, with leading stocks now suffering sizable declines that suggest institutional liquidation, investors should have their respective defensive teams on the field, and be looking for opportunistic, out-of-favor investments that have already been discounted.

Thesis:

The market correction is gaining steam and will not be completed until leading stocks and market capitalization indexes correct materially.

Small-Caps & Transports Led The Downturn:

While U.S. stocks have outperformed international markets since 2011, 2014 and 2015 saw the development of material divergences. Specifically, smaller capitalization stocks, measured by the Russell 2000 Index, and represented by the iShares Russell 2000 ETF (NYSEARCA:IWM), began under performing in 2014. Importantly, small-caps went on to make a new high in 2015, but their negative divergence all the way back in 2014, planted the seeds for the current decline, as illustrated in the chart below.

Building on the negative divergences, transportation stocks began severely under performing the broader markets in 2015. To illustrate this, I have used the charts of two leading transportation stocks, American Airlines (NASDAQ:AAL) and Union Pacific Corporation (NYSE:UNP), which are depicted below. For the record, I have taken a fundamental interest in both companies as I believe they are leading operators in their industries.

The Next Dominoes – Oil Prices & High Yield Bonds:

Oil prices, as measured by the United States Oil Fund (NYSEARCA:USO) in the chart below, were actually one of the first shoes to drop, even prior to small-cap stocks, starting a sizable move down in June of 2014.

Industry stalwart Chevron Corporation (NYSE:CVX) peaked in July of 2014, and despite tremendous volatility since then, has been in a confirmed downtrend.

As the energy complex fell apart with declining oil prices, high-yield bonds, as measured by the iShares iBoxx High Yield Corporate Bond Fund (NYSEARCA:HYG), and by the SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK), made material new lows.

Yield Focused Stocks Take It On The Chin

As the energy downturn intensified, many companies that had focused on providing attractive yields, to their yield starved investors, saw their business models questioned at best, and implode at worst. The most prominent example was shares of Kinder Morgan (NYSE:KMI).

The fallout did not stop with KMI, as many MLP s and other yield oriented stocks continue to see declines as 2015 has rolled into 2016. Williams Companies (NYSE:WMB) has been especially hard hit, showing extreme volatility over the past several weeks.

Leading GARP Stocks Never Recovered:

Even though I have been bearish on the markets for some time, I was not sure if the markets would melt-up or meltdown in December of 2015, as I articulated in a Seeking Alpha article at the time.

In hindsight, the under performance of growth-at-a-reasonable-price stocks, like Apple (NASDAQ:AAPL) and Gilead Sciences (NASDAQ:GILD), which had struggled ever since the August 2015 sell-off, should have been an ominous sign.

FANG Stocks, The Last Shoe To Drop:

Even as many divergences developed in the financial markets over the last year, many leading stocks made substantial new highs in the fall of 2015, led by the FANG stocks. Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), and Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), along with NASDAQ stalwarts Microsoft (NASDAQ:MSFT) and Starbucks (NASDAQ:SBUX), attracted global capital as growth became an increasingly scarce commodity. The last two weeks have challenged the assumption that these companies are a safe-haven, immune from declines impacting the rest of the stock market, as the following charts show.

The PowerShares QQQ ETF (NASDAQ:QQQ), which is designed to track the performance of the NASDAQ 100 Index, and counts five of the world’s ten largest market capitalization companies among its largest holdings, Apple, Alphabet, Microsoft, Amazon, and Facebook, has outperformed the S&P 500 Index, as measured by the SPDRs S&P 500 ETF (NYSEARCA:SPY), for a majority of the current bull market, with a notable exception being the last week of 2015, and the first two weeks of 2016. Wholesale, sustained selling is now starting to grip the markets.

Conclusion – The Market Downturn Is Gaining Momentum:

The developing market correction is gaining momentum. Like an avalanche coming down a mountain, it is impacting everything it touches, and no sectors or companies, even the previously exalted FANG stocks, are immune from its reaches. Investors should have their respective defensive teams on the field, while looking for opportunities in undervalued, out-of-favor assets, as many stocks have been in their own bear markets for years.